The Promises and Risks of Commercializing Microfinance
I have been working in the microfinance sector for about 15 years, with MFIs in institutional development and on the investor side, raising and placing a series of funds to invest equity in MFIs. I have also served on the boards and investment committees of MFIs and investment funds in various countries. From these vantage points, I have been able to observe and participate in the struggles managers and funders face over the questions of maximizing impact, mission drift, balancing financial and social objectives, and appropriate rates of financial return: in short, the promise and the risk of commercialization.
Based on these experiences, I have come to believe that there can be no single model of commercial microfinance for several reasons. First, the motivations of staff, managers, and funders are diverse, ranging from the purely commercial to the predominately social. Second, even within the social or impact investment community, there are diverse views regarding how microfinance can best maximize impact. For example, some emphasize rapidly achieving massive scale while others focus on delivering tailored packages of interventions that address specific development challenges.
The performance of the industry has mitigated and obscured the tensions created by commercialization and accessing mainstream capital markets. The unmet need for financial inclusion nearly everywhere meant that social impact, if defined as access, was relatively easy to demonstrate, and financial performance driven by high growth rates and limited competition seemed likely to meet mainstream commercial thresholds. Many MFI managers, fund managers and investors – including me! – sincerely believed that tradeoffs between social and financial performance either did not exist, or probably more precisely, were negligible.
Those days are gone. Mere access is no longer the preeminent need in many markets, and a stream of research studies have confirmed the intuition of many long-time practitioners that access to financial services in and of itself may do little good, and in some cases, even cause harm. On the financial side, achieving performance that mainstream investors expect or require looks a lot more challenging now than it did two years ago.
The initial reaction of the industry, to its credit, has been to put major efforts into consumer protection, greater transparency and codes of conduct for MFIs and, more recently, investors. Huge progress has been made over the past two years in setting a meaningful “do no harm” standard with concrete tools for enabling credible assessments.
These initiatives can go a long way towards preserving the character of microfinance. But their limitations must also be recognized. There have been ample examples of egregiously damaging products and practices directed at low income borrowers in the U.S. which took place with the active participation of prominent and respected listed companies, under the scrutiny of a sophisticated regulatory system, in an environment of high literacy and ample sources of information, and despite the determined efforts of a developed network of consumer advocates.
The “do no harm” standard, essential and important as it is, also threatens to give a new lease on life to a damaging delusion: that we can set both profit maximization and social improvement – not just avoidance of harm but demonstrable improvement in opportunities and outcomes with respect to poverty, gender, community empowerment – as simultaneous priorities. It’s clear to social investors that these are both essential to microfinance. But prioritization — to be useful to managers, staff or investors — must provide a basis for choosing when conflicts arise.
As recent research has shown there are both synergies and tradeoffs between social and financial objectives. There is undoubtedly a “long run business case” to be made for responsible finance. But the industry’s clients, investors, and practitioners are poorly served if we neglect to prepare managers and investors for occasions where choices must be made and simply insist that the two priorities are always mutually reinforcing. Instead MFI managers, investment managers and investors must all articulate more clearly where their priorities lie, what their financial and social return requirements are, and be prepared to act on these priorities at the expense of other, explicitly lesser goals.
Being explicit about priorities is not the same as saying that profitability and responsible, pro-poor microfinance are incompatible. Indeed, there is lots of anecdotal evidence that profitability and client focus can be mutually reinforcing and form the core of a successful business model, as Michel Burbano illustrated with the example of Bco Solidario. But if profit maximization carries risks to the social character of microfinance, and when it is set as the priority to satisfy investor requirements, microfinance may not always be able to “withstand the greater influences of wealth and power that surround us in the world” but will in fact, dedicate itself to their service.
By self-identifying as “financial-first” or “social first” MFIs, fund managers and investors enable us to move beyond the idea that there is a single model of commercial microfinance in which social and financial objectives can generally be achieved without tradeoffs, and that a conventional shareholder corporation is always the best vehicle for commercial MFIs. Ramesh Ramanathan’s dual for-profit, non-profit structure is one approach, and other models are emerging around the world – social business, benefit corporations, common good corps — that specifically prioritize social outcomes within a for-profit structure.
So in summary, the news regarding commercialization is good. Minimum standards are being set and widely recognized that will enable investors to screen out the most unscrupulous operations and reduce if not eliminate the likelihood of the “return of usurers” in the guise of MFIs. Commercial microfinance has matured to the point that it can accommodate and put to good use different models, which we can take advantage of in order to better align investor, management and staff objectives.